Business Owner’s Guide: Where to Begin With Small Business Accounting

The goal of running a business is to make money, but if you’re not tracking the numbers correctly, you’ll never be able to optimize your financial potential. Small business accounting isn’t just a chore or something you need to deal with at tax time. It’s a critical component of a successful business. 

Small business accounting includes all of the efforts you make to track and organize financial essentials for your business. It includes bookkeeping and tax prep, but it also includes paying employees, managing invoices, and tracking inventory. Handling your accounting correctly ensures you know where your money is coming from and where it’s going. It also keeps you compliant with employment and tax regulations. 

Your accounting records give you insight into the health of your business. They can also help you draw in investors or apply for loans. As a small business, the way you approach small business accounting will have a direct impact on the health and longevity of your business, but it can be hard to know how to get started. This guide outlines the accounting decisions to make before opening your business. It also provides practical tips on how to manage your accounting and explains how to get help.  

Setting Up for Small Business Accounting

You’ll need to make several decisions before you take on your first client or sell your first product. Here are five accounting decisions new business owners should make before they launch.

1. Select a Business Structure

Your business structure affects you from a legal and tax perspective. Non-incorporated businesses such as sole proprietorships and partnerships are legally indistinguishable from their owners. People who own these businesses are responsible for the business’s debts and legal liabilities. They also report all profits directly on their personal tax returns and face both payroll and income taxes. 

Note that a partnership requires a standalone tax return, but you carry the profits over to the partner’s personal returns. You never make a tax payment with a partnership income tax return. It’s just a reporting obligation. 

A limited liability company (LLC) establishes a business as a separate entity from its owners. The owners are not responsible for the business debts, and if someone sues the business, the owners aren’t liable. An LLC, however, is not a tax entity. You are still taxed as a sole proprietor or a partnership unless you decide to incorporate. 

Incorporation significantly changes the taxation of your business income. The business pays owners and/or partners a salary that is subject to payroll taxes. The business may also issue dividends to shareholders. Remaining S corporation profits, if applicable, flow to owners and face income tax. C corporations (the most common type of corporation) face corporate income tax on any profits that are not distributed to shareholders. 

Small businesses by default are sole proprietorships if they have a single owner – and they are partnerships if they have multiple owners. You will need to do additional paperwork and file forms if you want to set up an LLC or corporation. A small business accountant can help you identify the most advantageous structure for your business from a tax and legal perspective. 

2. Choose an Accounting Method

Most small businesses can choose between the cash and accrual methods of accounting, or use a hybrid of both. Here is some information about how each method works:

• The cash method accounts for income and expenses as they are paid. This method is typically easier to manage for many small businesses.
• The accrual method accounts for income when earned and expenses when incurred regardless of when the payment exchanges hands. Businesses may want to use the accrual method in situations where it provides a more realistic portrayal of the timing between income and expenses.
• The hybrid method combines both of these options. You may elect to use a hybrid approach if it makes sense for your specific situation. 

There are slight nuances to all of these approaches, but these basic definitions give you the gist of the differences. Note that C corporations usually must use the accrual method. The only exceptions are for personal services corporations or corporations with average annual gross receipts of less than $27 million (as of 2022) for the three prior tax years.  

3. Identify Tax Obligations

Take some time to figure out your business’s tax obligations. All businesses need to file federal tax returns that show their income and expenses – even the smallest businesses and freelancers have this obligation if they have over $400 in net profit. Retailers may also need to deal with excise taxes. Businesses that hire employees need to file and remit payroll taxes. 

You may also have state-specific tax obligations. These can include state income tax withholding, sales tax, and franchise or corporate tax. You need to be proactive about identifying your tax obligations and will need to set up a system to track the numbers you need for each of your tax returns. You may also want to invest in software or hire a professional to provide your small business accounting services and to help you file your returns. 

Paying for tax prep services is an extra expense, but it’s also an investment into your business. Failure to file federal or state business tax returns on time can lead to significant penalties and interest. A lack of compliance can even threaten your business licenses.

4. Outline a Chart of Accounts

Your accounting records should be sorted into a chart of accounts. You will sort your income and expenses into these accounts, and you will also use them to track what the company owns and its loans. The chart of accounts provides the organizational framework for your accounting records. 

The main categories include assets, liabilities, revenue, expenses, and equity. You will also need to create subcategories in each of these charts. You may, for instance, want to track the revenue for different products or services separately, or you may want to break down expenses into categories such as rent, utilities, and office supplies, for example. 

5. Set Up Accounting Processes

You now know your business structure, your desired accounting method, and your tax obligations. You also have a general sense of how you want to organize your accounting records into a chart of accounts. Next, identify processes that bring it all together and help you stay on top of everything. The optimal processes vary from business to business. 

You need processes to track your financials. This can take a vast range of forms depending on the complexity of your business. It may involve putting receipts into a shoe box and then entering them into a spreadsheet once a month. It may involve a team of people who manage your accounts payable, distribute checks to your vendors, and enter the expenses into accounting software. 

You also need to set up processes for your tax obligations. Here is an example. Say you need to pay sales tax. You may decide to use your point-of-sale system or eCommerce software to track sales. You may, then, set up an online account with your state department of revenue so you can file your own sales tax returns. An alternative would be to send your sales numbers to a small business accountant so they can file the returns for you. 

There are all kinds of ways to approach small business accounting and tax prep. You can handle it on your own. You can outsource everything. You can take a hybrid approach where you do some and let a professional handle the rest. Consult with a specialist to ensure you’re using the best method for your situation. 

Practical Tips for Small Business Accounting

Working through the above tips will give you the foundation you need, but once you make those decisions, you need to actively start the accounting process. Here are some tips to help stay on top of your financials. 

Open Business Accounts

A separate business account makes it easier to stay on top of the numbers. It can also be critical if you’re applying for loans as many lenders insist upon seeing several months of business bank account records. Open a business account and only use it for business expenses. Don’t use other accounts to cover business expenses or it will lead to confusion. 

Track Expenses Diligently

Tracking your expenses helps you understand how much your business is earning. It can also help ensure you don’t incur an unnecessarily high income tax liability. You will face personal or corporate income tax on your profits, and you determine this number by subtracting your expenses from your revenue. Failure to track expenses could artificially inflate your profits and your tax bill. Create a dedicated system for tracking expenses and follow it diligently. 

Make Sure You Understand Your Tax Deductions

Your operating expenses aren’t the only deductions you can take at tax time. You can also deduct depreciation for capital assets, amortization, and interest on business loans. It’s also worth researching whether you can claim deductions for self-employed health insurance or for setting up retirement accounts for you or your employees, as this is often an option.

Some people qualify for special credits or deductions depending on the type of business they run, as well. You need to understand your deductions and credits so you can track the appropriate numbers during the tax year. 

Set Aside Regular Time for Bookkeeping

Bookkeeping is always easier to handle if you stay on top of it. Falling behind can cause you to overlook expenses and revenue. Haphazard bookkeeping gives you an inaccurate sense of your business’s financial situation. It can also make it hard to comply with tax reporting obligations. 

You can’t just estimate your financials for tax returns. You need to use accurate numbers. Failure to do so can lead to accuracy-related penalties, and in cases where you substantially understate the numbers, you may even face evasion charges or penalties for negligence. Setting aside regular time for bookkeeping helps minimize these risks. 

Budget for Tax Obligations

You must pay your taxes on time if you want to stay compliant with government regulations and avoid unnecessary penalties and interest. Make sure you understand your tax obligations, project how much you’re going to owe, and budget for those payments.  

Generate Reports to Learn More About Your Business

Bookkeeping, in general, refers to the process of tracking your numbers. Accounting, however, goes a step further and helps you make sense of your financial picture. Generating reports can help you gain insights into how your business is doing. 

You may want to track which projects have the highest profit margins. You may also want to isolate your profits based on the time of day to see if you need to alter your hours. You may want to track the return on investment for marketing expenses. There are countless indicators you can track and all kinds of reports you can generate, but again, it all starts with having the right numbers in place. 

Identify Areas for Growth

One reason to generate reports is to find areas for improvement. Your accounting reports can help you analyze cash flow patterns, narrow in on optimal price points, streamline inventory management, and more. Leverage your reports to identify areas where you can improve, and then, track your efforts and adjust your approach as needed. 

Small business accounting can be a complex process, and whether you run a very small company or a corporation, it’s a critical component of your business’s success. A small business accountant can help ensure you’re taking the best approach to accounting, and they can guide you toward the right financial strategies for your business. 

Get Help With Small Business Accounting Services

The Silver Tax Group can help with your small business accounting needs. We can also help with tax issues that may occur if you’ve been ignoring your small business accounting. We offer tax resolution services, help with audits, assistance with unfiled returns, emergency tax services, and business tax consulting. We want to see our clients succeed, and the numbers play a big role. Contact us today at the Silver Tax Group to learn more and get help with your small business accounting.